Foreign Exchange Swap - Pricing

Pricing

The relationship between spot and forward is known as the interest rate parity, which states that

F = S \left( \frac{1+r_d T}{1+r_f T}\right) ,

where

  • F = forward rate
  • S = spot rate
  • rd = simple interest rate of the term currency
  • rf = simple interest rate of the base currency
  • T = tenor (calculated according to the appropriate day count convention)

The forward points or swap points are quoted as the difference between forward and spot, F - S, and is expressed as the following:

F - S = S \left( \frac{1+r_d T}{1+r_f T} -1 \right) = \frac{S (r_d - r_f) T}{1+r_f T} \approx S \left( r_d - r_f \right) T ,

if is small. Thus, the value of the swap points is roughly proportional to the interest rate differential.

Read more about this topic:  Foreign Exchange Swap